Municipal Bond Market Recap And Outlook

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Includes: ACTHX, ATFAX, VKLMX, VKMMX
by: Invesco US

Summary

Municipals emerged as the best performing asset class in 2015, bolstered by positive supply/demand technicals, low interest rates and constructive US economics.

The municipal market enjoyed a number of favorable technical factors during the year - primarily expectations of a flatter yield curve, strong demand and a lower-than-expected muni supply.

The Federal Open Market Committee (FOMC) increased the federal funds target rate for the first time since June 2006.

By Mark Paris and Stephanie Larosiliere

Arguably, the most distinguishing aspect of 2015 was the scarcity of positive returns across various asset classes. The sleepy US municipal bond market, however, was one of the few sectors that exhibited relative stability in the midst of a global sell-off in equities, commodities and high yield corporate bonds. US tax-exempt bonds emerged as the best performing asset class in 2015, bolstered by positive supply and demand technicals, low US interest rates and constructive US economic conditions.

Figure 1: Municipals - One of the best performing asset classes two years in a row

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Source: Barclays, as of Dec. 31, 2015. IG municipal bonds are represented by Barclays Municipal Bond Index; HY ex-PR municipal bonds by Barclays Municipal High Yield Bond Index (excluding Puerto Rico); domestic equities by S&P 500 Index; US Treasuries by Barclays U.S. Government Index; US bonds by Barclays U.S. Aggregate Bond Index; US IG corporate bonds by Barclays U.S. Corporate Investment Grade Index; developed foreign equities by MSCI EAFE Index; domestic small cap by Russell 2000 Index; US corporate HY by Barclays U.S. Corporate High Yield Index; and emerging market equities by MSCI Emerging Markets Index. Past performance is not a guarantee of future results. An investment cannot be made directly into an index.

Falling oil prices appear to be dragging on global markets. The corporate bond market, particularly high yield, has been subject to extreme pressure since early 2015, mainly due to commodity price weakness and potential defaults in commodity-related sectors. The possibility of a sell-off by oil states' sovereign wealth funds has harmed investor sentiment. The oil industry is also cutting back on capital spending, spreading the pain across supply chains. And the cost of borrowing for risky credits across the economy has risen, due to heightened risk aversion among investors stung by rising energy sector default rates.

Although municipal bonds emerged relatively unscathed from the energy-related jitters of the second half of 2015, the tax-exempt market was not without its ups and downs during the year. Dominating the municipal headlines were the budget impasses in the states of Illinois and Pennsylvania, news of Chicago's unfunded pension liabilities and the threat of default from Puerto Rico. However, while these issues were worrisome, they were not enough to outweigh the benefits of positive US economic performance.

Despite investor anxiety surrounding interest rates, municipals were able to achieve positive returns in three out of the four quarters this year. Over the 2015 calendar year, investment grade municipals returned 3.30% (5.83% on a tax-adjusted basis) and high yield municipals (excluding Puerto Rico) returned 7.53% (13.3% on a tax-adjusted basis).1,2 In comparison, the broad equity market returned 1.38% for the year, the US investment grade corporate market was down -0.68% and the high yield corporate market was down even further, returning -4.47% in 2015. For the fourth quarter, investment grade municipals returned 1.50% and high yield municipals (excluding Puerto Rico) returned 2.85%.1

As the broader markets experienced volatility, municipals fared significantly better primarily due to the limited supply backdrop and the continued strong investor demand. It is important to note that, especially among retail investors, positive mutual fund flows have historically tended to follow positive returns. Therefore, after several quarters of positive returns in 2015, it is not surprising that demand for municipals grew last year, generating net inflows into tax-exempt mutual funds totaling $15.8 billion.

Municipals outperformed Treasuries over the quarter, which was more pronounced after the FOMC raised rates towards the end of the year. Following the much anticipated first Fed hike in close to a decade, municipal yields and ratios are now lower. While long rates trended upwards through the first half of the year, they reversed course during the second half when 30-year AAA general obligation (GO) bonds ended the year at 2.82%, down 22 basis points (bps) from the third quarter, and bringing rates back to where we started at the end of 2014.

The 10-year AAA GO rates declined by 11 bps, flattening the curve as yields on intermediate- to long-term maturities declined more than the short end. In contrast, 30-year Treasury rates increased by 14 bps and the 10-year increased by 21 bps, leading municipals to outperform Treasuries over the quarter. Heightened demand and seemingly insufficient supply have richened relative valuations, which are currently at or close to their highs for the year. Municipal yields ended the year at 94% of Treasury yields.

Figure 2: Longer-maturity bonds outperformed shorter-maturity bonds as the yield curve flattened. Fourth quarter 2015 shift of AAA general obligation yield curve with changes in basis points.

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Source: Municipal Market Monitor (TM3) and US Treasury, as of Dec. 31, 2015. Past performance is not a guarantee of future results.

US Federal Reserve

On Dec. 16, 2015, the US Federal Reserve (Fed) raised the target range for the federal funds rate by 25 bps, to 0.25-0.50%. This hike occurred nearly seven years to date that the Fed moved to the target range of 0.00-0.25% in the midst of the "Great Recession."

Longer maturity US bond yields were minimally changed as a result of the hike, resulting in a flatter yield curve. Going into 2015, investors were anticipating a rate hike and a flattening of the yield curve. When this did not materialize, the yield curve steepened in the first half of 2015, but investors that stayed the course were rewarded in the second half of the year when the curve flattened and investing in long duration bonds paid off. For the second year in a row, long-dated municipal bonds outperformed, indicating that shifting to a short duration municipal portfolio was costly. Investors with a higher risk tolerance would be better served with an allocation to high yield municipal credits.

The FOMC's December statement implied gradual rate increases that are slower than past hiking cycles. We expect the Fed to raise interest rates at a slow and measured pace throughout 2016 with one possible hike of 25 bps (although global asset volatility, a stronger US dollar and tighter financial conditions could alter this). While a move to higher rates can cause volatility, as municipal yields become more appealing, institutional, retail and crossover investors may jump in to put cash to work, thus bolstering demand for the asset class.

Demand

With total returns for the municipal market being positive (and holding up better than other asset classes), lower volatility of municipals and the attractive after-tax yields, investors increased their demand for municipals in the second half of the year, particularly in the fourth quarter. Municipal bond funds experienced three consecutive months of inflows in the fourth quarter, reversing a five-month trend, with a total of $10.6 billion going into municipal funds during the fourth quarter and $15.8 billion for the year.3 Also, increasing municipal demand have been global risk factors such as China, European Central Bank policy and decreased energy prices, which have not affected the municipal market to the same degree as other markets.

It is important to remember that municipal bond funds are typically retail-owned, and flows tend to follow returns, as investors will tend to base asset allocation decisions in part on past performance. As a result, inflows will tend to follow positive returns, as shown in Figure 3. Given that municipals outperformed both taxable fixed income and equities in 2015, we expect this relationship to hold true in early 2016, with continued inflows into municipal bond funds.

Figure 3: Municipal funds have experienced net inflows of over $15 billion year to date. Monthly municipal bond fund net flows and municipal index price history.

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Source: Morningstar and Barclays, as of Dec. 31, 2015. Past performance is not a guarantee of future results. An investment cannot be made directly into an index.

Supply

Since the expiration of the Build America Bond program in 2010, new money issuance in the municipal market has fallen below historical averages and 2015 was no exception. New money issuance in the tax-exempt market totaled just $151 billion in 2015, compared to an average of nearly $200 billion over the last 20 years.4 Under normal market conditions, new money tends to comprise the majority of total bond issuance; however, since 2012, there has been a shift and re-financings now represent the bulk of total new issuance. Municipal bond prices benefited from the low supply and we expect 2016 issuance to be comparable to 2015.

The 2015 calendar year supply ended at $398 billion, higher than the total of $334 billion for 2014.4 Refundings continued at a higher pace in 2015, driving the bulk of supply over the year, with 41% of new issues being refundings. However, the pace of refundings decreased in the second half of the year as higher rates drove refunding activity lower.

Figure 4: 2015 supply ended higher than 2014, with the bulk of issuance coming as refundings. Municipal bond issuance ($ billion).

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Source: The Bond Buyer, as of Dec. 31, 2015.

The low level of new money issuance in recent years has puzzled many investors. We believe there are a few factors that have deterred new money bond issuance in the municipal market including:

  1. The fiscal health of many US cities has improved since the depths of the "Great Recession." But despite three consecutive years of budget growth, revenues are not keeping pace. Like many other metrics that have tracked economic recovery, fiscal revenues have shown a very slow and extended period of improvement. This has led to cautious behavior by many finance officers at state and local government levels. Many officials have decided to proceed carefully with spending programs as the recovery slowly proceeds.
  2. In recent years, many state and local governments have been focused on channeling their resources and capital toward meeting unfunded pension liabilities and increased Medicaid costs rather than borrowing to fund projects such as infrastructure rebuilding.
  3. At the state level, there also seems to be reluctance to, and in many cases an explicit philosophy against, imposing tax increases. Despite the Fed's increase in interest rates, we expect a number of factors in 2016 to support supply, such as a continued improvement in state and local tax revenue.

State of the states

While states have largely overcome the effects of the "Great Recession," which began in 2008, financial pressures remain that will continue to shape state budgets. States are challenged by accumulations of unfunded pension and retiree healthcare liabilities, which total more than $1 trillion nationwide.5 However, many governments noted improvements since the end of the economic downturn including business expansion, lower unemployment and increased consumer spending, while the overall improvement in most state economies has led to more stable fiscal conditions.

A look at the governor's budget recommendations for fiscal 2016 found that a majority of governors are projecting modest revenue growth, moderate increases in state spending and rainy day fund levels that are at or near historical averages. Proposals for fiscal 2016 remain mostly cautious with limited spending growth, with an emphasis on ensuring that budgets are structurally balanced and sustainable in the future.

State and local tax revenue has been trending upwards since 2009. The latest available data as of the third quarter illustrates that tax revenues for the four largest tax categories (property, sales, individual income, and corporate net income) increased 5.7% to $287.7 billion, up from $272.2 billion in the third quarter of 2014.6 Looking back at historical totals on a 12-month basis as of the third quarter, tax revenue totaled $1.3 trillion primarily from revenue through property and individual income taxes.

Figure 5: State and local government tax revenue has been trending upwards

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Source: US Census Bureau, Quarterly Summary of State and Local Tax Revenue. 12-month ending quarterly data as of Dec. 22, 2015.

Liquidity

Liquidity in fixed income markets has become a major focus of concern inside and outside of the investing community. Concerns grew in the fourth quarter as the Federal Reserve prepared to raise interest rates, as investors feared that we may be entering a "perfect storm" where fears of rising interest rates could cause bond investors to simultaneously rush for the exits. In the municipal market, this can create a negative feedback loop, where selling begets more selling, resulting in unreasonably low security prices and a lack of market liquidity.

Liquidity is the ease with which an investment can be purchased and sold, and liquidity risk refers to the risk that there may not be a significant market for the purchase and sale of bonds. Illiquid bonds tend to have several characteristics in common, such as their tendency to be lower-rated credits from smaller-sized deals. Typically, the larger the issue and higher the quality of the bond, the greater the liquidity tends to be. Given that municipals trade over-the-counter (OTC), market liquidity is of particular importance.

This means that in order for a buy or a sell to take place both the buyer and seller must agree on a price. When a buyer views a bond as particularly hard to sell, a lower price will be demanded as compensation for any potential difficulty in the future. The liquidity risk inherent to the municipal market is the risk that large outflows may lead mutual funds to sell bonds at depressed prices to meet redemptions, which would affect the performance of the portfolio.

While liquidity is a concern for the retail-dominated asset class, there are characteristics of the tax-exempt bond market that can provide a foundation for healthy liquidity, such as:

  • Cash flow generation: Municipal bonds generate substantial annual cash flows, which are largely independent from refinancing concerns. These cash flows, combined with mutual fund cash holdings, provide inherent structural liquidity for municipal bond mutual funds.
  • Investment grade dominance and minimal defaults: The municipal bond market is dominated by investment grade credits with very low historical default rates compared to the corporate bond market. High ratings and low default rates support both investor confidence and asset class liquidity when systemic risk is elevated.
  • Minimal growth since 2009: Growth of the municipal bond asset class has been flat since 2009. By this measure alone, municipal bond mutual fund redemption risk remains similar to prior the financial crisis. In 2008, the Invesco Municipal Bond team anticipated the redemptions and held higher cash balances in its funds, managing liquidity effectively.

At Invesco, our municipal portfolios have built-in sources of liquidity to meet redemptions in all market conditions. Liquidity is considered on an on-going basis in our portfolios and our portfolio managers are always factoring how our daily purchases and transactions affect the overall liquidity of the portfolio.

The Invesco Municipal Bond team manages our portfolios to ensure liquidity across our strategies in a number of ways:

  • Exposure to pre-refunded bonds: Within the municipal bond market, these types of bonds are considered the highest quality and typically receive a AAA-rating because the interest and principal payments come from Treasury securities. When issuers want to take advantage of lower interest rates but are not able to call the bonds, they issue new bonds and place the proceeds into an escrow account that is then used to pay off bondholders when the bonds can be called. The escrow accounts are funded with US Treasuries, resulting in a AAA-credit rating and a liquidity profile that is comparable to Treasuries. These types of bonds are heavily traded and very liquid. At Invesco, our municipal strategies hold an average of 6% in pre-refunded bonds (across open and closed funds as of Dec. 31, 2015).
  • Cash received from interest payments: Each of our funds receive cash from scheduled principal and interest payments on its underlying holdings. This cash typically arrives twice a year and serves as a crucial source to meet redemptions.
  • Size: Municipal bonds are traded in an over-the-counter market. Typically, illiquid bonds are lower-rated credits and derived from smaller-sized deals, whereas issuers of more liquid bonds are typically those for which there is a large trading volume and a large number of dealers that routinely buy and sell the bonds. Our size allows us to trade in upwards of $100 million-sized lots and allows us to have access to a wide array of information that smaller investors may not be privy to. Our relationships with broker dealers allow us to not only obtain favorable bond terms, but also provide us with transparency on trade history and market developments. In addition, our tenured municipal credit analysts allow us to go beyond the credit ratings to assess the fundamental credit quality of the issuer, delving into the legal provisions of each and every bond.
  • Trading frequency: In the equity markets, an analysis of liquidity will often focus on trading volume and frequency. A stock that trades frequently and "in size" is considered liquid. Stocks exhibiting those trading characteristics will generally have narrow bid-ask spreads. However, this is not the case with many municipal bonds, particularly the older and higher-quality municipal bonds that generate higher income. While many of these bonds have not been sold in some time, should they be sold, they would trade very quickly due to their high income.

Outlook

We expect many of the factors that drove the positive performance of municipals in 2015 to remain in place in 2016. We believe expectations of a flatter US yield curve and another year of slow but steady modest economic growth will bode well for municipal bonds. As such, our outlook for 2016 is similar to 2015, with performance expected to be predominately driven by coupon return.

Our view rests on the assumption that inflation remains relatively subdued and the Fed raises interest rates gradually. We expect new bond supply to remain below historic averages as issuers face a variety of spending and other constraints, as noted above, and investors find themselves faced with an ever-increasing tax burden, which we believe is likely to reinforce demand for municipal bonds.

Four reasons to consider municipal bonds

  1. Tax advantage: New laws, as well as tax provisions that expired at the end of 2013, have led to larger tax bills for many high-income earners. Some of the significant changes to tax law include a top marginal rate of 39.6%, up from 35%; a 20% tax on long-term capital gains and dividends, up from 15%; and a new, 3.8% tax on investment income from which municipal income is exempt. We believe that these higher tax rates will increase the incentive for taxpayers to seek tax-exempt income via municipal bonds. Municipals have the potential to offer a broad range of investment options that are exempt from federal income tax and can be exempt from state and local income taxes. However, income may be subject to the alternative minimum tax (AMT).
    Figure 6: Municipal bonds can potentially provide attractive taxable equivalent yields Click to enlarge

    Source: Barclays and Bloomberg L.P., as of Dec. 31, 2015. High yield corporate bonds are represented by the Barclays U.S. Corporate High Yield Index; high yield municipal bonds by the Barclays High Yield Municipal Bond Index; investment grade municipal bonds by the Barclays Municipal Bond Index; and investment grade corporate bonds by the Barclays U.S. Corporate Investment Grade Index. Past performance is not a guarantee of future results. An investment cannot be made directly in an index. The tax-adjusted calculation uses a tax rate of 43.4%, which is the top federal tax bracket of 39.6% + the net investment income tax of 3.8%. Past performance is not a guarantee of future results. An investment cannot be made directly into an index.

  2. Diversification potential: We believe diversification can potentially increase opportunities for growth and reduce overall portfolio volatility. Because municipal bonds have historically had very low correlation to other asset classes, including equities and Treasuries, they can be effective portfolio diversifiers. As shown in Figure 7, the Barclays Municipal Bond Index and Barclays High Yield Municipal Bond Index have exhibited low correlations of 10% and 27%, respectively, to the S&P 500 Index. This is in contrast to the Barclays U.S. Corporate High Yield Index, which has had a much higher 73% correlation with the S&P 500 Index over the same time period.
    Figure 7: Municipals have offered equity investors higher diversification benefits than corporates. 10-year asset class correlations.
    1 2 3 4 5 6 7 8 9 10
    1 Barclays Municipal Index 1.00 0.64 0.53 0.56 0.35 0.31 0.10 0.14 0.13 0.06
    2 Barclays High Yield Municipal Index 0.64 1.00 0.19 0.35 0.47 -0.08 0.27 0.31 0.27 0.19
    3 Barclays U.S. Aggregate Bond Index 0.53 0.19 1.00 0.81 0.24 0.87 0.04 0.16 0.13 -0.03
    4 Barclays U.S. Corporate IG Index 0.56 0.35 0.81 1.00 0.62 0.46 0.34 0.47 0.47 0.27
    5 Barclays U.S. Corporate High Yield Index 0.35 0.47 0.24 0.62 1.00 -0.23 0.73 0.75 0.76 0.71
    6 Barclays U.S. Government Index 0.31 -0.08 0.87 0.46 -0.23 1.00 -0.29 -0.19 -0.23 -0.33
    7 S&P 500 Index 0.10 0.27 0.04 0.34 0.73 -0.29 1.00 0.79 0.89 0.91
    8 MSCI EM Index 0.14 0.31 0.16 0.47 0.75 -0.19 0.79 1.00 0.89 0.73
    9 MSCI EAFE Index 0.13 0.27 0.13 0.47 0.76 -0.23 0.90 0.89 1.00 0.80
    10 Russell 2000 Index 0.06 0.19 -0.03 0.27 0.71 -0.33 0.91 0.73 0.80 1.00
    Click to enlarge

    Source: Morningstar, for the period Jan. 1, 2006 to Dec. 31, 2015.

    This lower correlation illustrates that investment grade and high yield municipal bonds have not moved to the same degree as their corporate counterparts when the equity market rises or falls. We believe that this low correlation can potentially enhance a portfolio's diversification benefits.
  3. Relatively lower default risk: Contrary to popular belief, the vast majority of municipal bond issuers remain creditworthy and municipal default rates have remained relatively low, especially when compared with US corporate bonds. As shown in the chart below, when the credit structure decreases, the odds of a default rise. However, they are much higher for investment grade corporates compared with municipals. Since 1986, there has never been an AAA-rated municipal bond default. Similarly, in the same time frame, only 0.03% has defaulted with an AA-rating. By contrast, AA-rated corporate issuances have had a nearly 1% default rate since 1981.
    Figure 8: Municipals have offered equity investors higher diversification benefits than corporates. 10-year average cumulative default rate.
    Rating categories (1986-2014)
    Municipal bonds %
    (1981-2014)
    Corporate bonds %
    AAA 0.00 Figure 8: Municipals have offered equity investors higher diversification benefits than corporates 0.74
    AA 0.03 0.82
    A 0.09 1.51
    BBB 0.42 4.06
    BB 4.28 13.74
    B 11.85 25.91
    CCC-C 39.02 50.73
    All S&P investment grade 0.14 2.24
    All S&P non-investment grade 8.71 21.97
    All S&P rated securities 0.24 9.15
    Click to enlarge

    Source: Standard and Poor's, as of May 2015. Past default rates are no assurance of future default rates. The data presented is the most recent data available from the various bond rating agencies. 2015 data may increase cumulative default rates from both municipal and corporate bonds. A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO) of the creditworthiness of an issuer with respect to debt obligations, including specific securities, money market instruments or other debts. Ratings are measured on a scale that generally ranges from AAA (highest) to D (lowest); ratings are subject to change without notice. For more information on rating methodologies, please visit the following NRSRO website: standardandpoors.com and select 'Understanding Ratings' under Rating Resources on the homepage.

  4. Return per unit of risk: Looking at risk and tax-adjusted returns over the last 10 years, both the Invesco High Yield Municipal and Municipal Income Funds have outperformed most asset classes - some, including equities, with significantly less volatility.
    Figure 9: Municipals have offered most return per unit of risk on a tax-adjusted basis. 10-year annualized asset returns vs. volatility. Click to enlarge

    Source: Barclays, as of Dec. 31, 2015. Invesco fund performance shown is Class A shares at NAV. If sales charge had been included, performance would be lower. The tax-adjusted annualized return calculation uses a tax rate of 43.4%, which is the top federal tax bracket of 39.6% + the net investment income tax of 3.8%. Credit represented by the Barclays U.S. Credit Index; corporate high yield by the Barclays U.S. Corporate High Yield Index; domestic equities by the S&P 500 Index; and US Treasuries by Barclays U.S. Government Index. Volatility is measured by standard deviation. Past performance is not a guarantee of future results. An investment cannot be made directly into an index.

Average annual total returns (%) as of Dec. 31, 2015

1-year 3-year 5-year 10-year Since inception
Class A shares Symbol Max load NAV Load NAV Load NAV Load NAV Load NAV Load
Invesco Limited Term Municipal Income Fund ATFAX 2.50 1.40 -1.16 1.65 0.81 3.71 3.19 3.92 3.66 3.53 3.33
Invesco Intermediate Term Municipal Income Fund VKLMX 2.50 2.87 0.28 2.87 2.01 4.64 4.11 4.21 3.95 4.84 4.72
Invesco High Yield Municipal Fund ACTHX 4.25 6.26 1.77 5.36 3.84 8.20 7.26 5.03 4.57 6.18 6.02
Invesco Municipal Income Fund VKMMX 4.25 3.70 -0.71 3.57 2.08 6.07 5.15 4.05 3.60 5.21 5.03
Click to enlarge

Performance quoted is past performance and cannot guarantee comparable future results; current performance may be lower or higher. Visit invesco.com/performance for the most recent month-end performance. Performance figures reflect reinvested distributions and changes in net asset value (NAV). Investment return and principal value will vary so that you may have a gain or a loss when you sell shares. Performance shown at NAV does not include applicable front-end sales charges, which would have reduced the performance. Class A share performance reflects any applicable fee waivers or expense reimbursements. Had fees not been waived and/or expenses reimbursed in the past, returns would have been lower. Returns less than one year are cumulative, all others are annualized. The gross expense ratio on Class A shares for Invesco Limited Term Municipal Income Fund is 0.63%, Invesco Intermediate Term Municipal Income Fund is 0.90%, Invesco Municipal Income Fund is 0.93% and Invesco High Yield Municipal Fund is 0.93%. Expenses are as of the fund's fiscal year end as outlined in the fund's current prospectus. Inception date for Invesco Limited Term Municipal Income Fund is Oct. 31, 2002; Invesco Intermediate Term Municipal Income Fund is May 28, 1993; Invesco High Yield Municipal Fund is Jan. 2, 1986; and Invesco Municipal Income Fund is Aug. 1, 1990.

About risk

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer's credit rating. Junk bonds involve a greater risk of default or price changes due to changes in the issuer's credit quality. The values of junk bonds fluctuate more than those of high quality bonds and can decline significantly over short time periods.

Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer's ability to make payments of principal and/or interest.

Treasury securities are backed by the full faith and credit of the US government as to the timely payment of principal and interest.

Income may be subject to state and local taxes and to the alternative minimum tax.

Puerto Rico's economic problems increase the risk of investing in Puerto Rican municipal obligations, including the risk of potential issuer default, heightens the risk that the prices of Puerto Rican municipal obligations, and may experience greater volatility.

An investment in emerging market countries carries greater risks compared to more developed economies.

Smaller companies offer the potential to grow quickly, but can be more volatile than larger-company stocks, particularly over the short term.

Returns of large capitalization companies could trail the returns of smaller companies.

Corporate bonds may offer a higher yield than government bonds, but are often considered riskier because they're not issued by the government. The interest of these bonds is taxable.

The funds are subject to certain specific risks. Please see each fund's prospectus for more information regarding the risks associated with an investment in the funds.

  1. Investment grade municipals are represented by the Barclays Municipal Bond Index and high yield municipals ex-Puerto Rico by the Barclays Municipal High Yield Bond Index (excluding Puerto Rico).
  2. 39.6% federal bracket plus 3.8% medical investment income tax = 43.4%.
  3. Strategic Insight, as of Dec. 31, 2015.
  4. The Bond Buyer.
  5. Pew Charitable Trust, "Insights From Fiscal 50's Key Measures of State Fiscal Health," as of Jan. 5, 2016.
  6. "Quarterly Summary of State and Local Government Tax Revenue for 2015: Q3," released Dec. 23, 2015.
  7. Alpha Strategic Insight Simfund/MF Desktop, based on assets under management as of Dec. 31, 2015.

Diversification does not guarantee a profit or eliminate the risk of loss.

The opinions expressed are those of the portfolio managers, are based on current market conditions and are subject to change without notice.

There is no guarantee the outlooks mentioned will come to pass. These opinions may differ from those of other Invesco investment professionals.

Barclays High Yield Municipal Bond Index is an unmanaged index considered representative of non-investment grade bonds. Barclays Municipal Bond Index is an unmanaged index considered representative of the tax-exempt bond market. Barclays U.S. Aggregate Bond Index in an unmanaged index considered representative of the US investment grade, fixed-rate bond market. Barclays U.S. Corporate High Yield Index is an unmanaged index considered representative of fixed-rate, noninvestment grade debt. Barclays U.S. Corporate Investment Grade Index is an unmanaged index considered representative of publicly issued, fixed-rate, nonconvertible, investment grade debt securities. Barclays U.S. Credit Index is an unmanaged index considered representative of publicly issued, SEC-registered US corporate and specified foreign debentures and secured notes. Barclays U.S. Government Index is an index that measures the performance of all public US government obligations with remaining maturities of one year or more. MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East. The index is computed using the net return, which withholds applicable taxes for non-resident investors. MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries. The index is computed using the net return, which withholds applicable taxes for non-resident investors. Russell 2000 Index is an unmanaged index considered representative of small-cap stocks. The Russell 2000 Index is a trademark/service mark of the Frank Russell Co. Russell® is a trademark of the Frank Russell Co. S&P 500 Index is an unmanaged index considered representative of the US stock market. Past performance is no guarantee of future results. An investment cannot be made directly in an index.

Fed Funds Rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. Correlation indicates the degree to which two investments have historically moved in the same direction and magnitude. Duration is a measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. Duration is expressed as a number of years. Rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. Standard deviation measures a fund's range of total returns and identifies the spread of a fund's short-term fluctuations. A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed income security.

©2016 Morningstar, Inc. All rights reserved. The information contained herein is proprietary to Morningstar and/or its content providers. It may not be copied or distributed and is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

Before investing, carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the products, visit invesco.com/fundprospectus for a prospectus/summary prospectus.

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Municipal bond market recap and outlook by Invesco US Insights

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.